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Farm Financial Planner: Transferring farmland, minimizing taxes

With good advice, land can be transferred to the next generation with minimal taxes

In Alberta, a couple we’ll call Henry, 63, and Maryann, 57, are third-generation farmers. They have 1,900 acres and a herd of 40 beef cows, far less than the 300 cows they had before the BSE crisis two decades ago. With too much land for their smaller herd, they rented land to neighbours and Henry went to town to do heavy machinery maintenance. It is a profitable farm, but one in decline. The issue now is the next generation. The parents want to transfer a not-very-profitable farm to adult children who want to do better.

The couple has two sons we’ll call Robert, 30, and Fred, who is 25. They have off-farm jobs but would like to farm. There are two other children who don’t want to farm.

The parents would like to retire comfortably, and allow their sons to take over the farm and be financially successful without having to take on a huge debt. Henry and Maryann consulted Don Forbes and Erik Forbes of Forbes Wealth Management Ltd. in Carberry, Man., for transition advice.

“We have to be alert to the tax implications of any plan,” Don Forbes says. “The best way is to aim for income tax averaging 25 to 33 per cent each year. If we defer all income to death of the partners, then the rate could be as much as 50 per cent or even more if you include Old Age Security clawback tax costs.”

The gain in the value of personally owned farm land will be offset by the $1 million Personally Owned Farm Land Capital Gains tax exemption for which each of the parents is eligible, and the allowable exemption of the primary residence farm home and one acre around it – say $200,000 in total. So the first $2.2 million of capital gains on the personally owned farm land will be exempt from federal tax, Don Forbes explains.

The parents can transfer land, equipment and inventory to the next generation at any price between book value and today’s market value. The goal in choosing a cost base is to use up all eligible tax credits and tax exemptions without claiming the entire market value of the farm and having to pay tax in the year of the transfer, Erik Forbes explains.

The farm has a market value of $2,880,000 and a book value of $128,000 — a capital gain of $2,752,000. The capital gains credit of $2.2 million knocks the exposure down to $552,000. There would be some Alberta tax payable, loss of two Old Age Security benefits when the gain is realized and taxed, and calculation of the Alternative Minimum Tax. The personal residence and the value of one acre continue to be free of tax on sale or transfer. That is separate from the Farmland Tax Credit calculation.

Other issues

Henry and Maryann’s goal is a set transfer price of book value plus the capital gains exemptions. Any remaining taxable gain balance would be deferred to the respective future owners through a lower notional purchase price. This amounts to a tax-free transfer of farming assets to the children.

The parents could take a zero per cent interest promissory note on the transferred land. The note should be drafted and signed while the parents are still living; it can be forgiven after the both parents’ death. This protects the parents’ future income if any of the inheriting children became involved in financial difficulties; it gives the sons land title, while the parents retain control.

The restructuring of farm ownership into the hands of two of four of the couple’s children will be sustainable. However, the farm cannot support the two children’s families and Henry and Maryann. Until the parents leave farm operations and retire, Robert and Fred should keep their town jobs, Don Forbes suggests.

This comes with a warning from Don Forbes. “The sons and the parents should formalize their arrangements with written plans, notes of amounts owing, testamentary plans drafted to include the debts, and, apart from the wills, a written plan for transition from the farm run by the parents to the farm run by the sons. It may seem overdone, but documenting what is to happen will not only keep the plan in view and eliminate future misunderstandings, but will also be a base for any legal or tax issues that might arise in future.”

About the author

Columnist

Andrew Allentuck is the author of 'When Can I Retire? Planning Your Financial Future After Work' (Penguin, 2011).

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